The 'guidance guarantee' - a step in the right direction but cannot deliver better outcomes for all..
The pension reforms that come into effect in April 2015 have seriously shaken up the pensions industry and have helped to put pension decumulation and the needs of retirees very firmly on the map. When attending social functions in recent months it has been pleasantly unusual to be confronted by questions from friends and strangers wanting to find out more about the pension changes and how it might affect them. Long may this continue and it needs to continue if we are to improve retirement outcomes for all – we, the industry, must continue to encourage retirees to engage with their retirement plans as happens far more effectively in many other developed countries.
The new pension changes bring flexibility and choice like never before but the fundamentals of retirement planning have not changed – ‘how much can you afford to spend to ‘live’ today and have the peace of mind you will have enough for all your tomorrows?’
However, beneath that simple sentence lies a multitude of variants that will be driven by a host of factors including health, personal financial circumstances, risks, age, resources, dependency and external factors. As such, improving retirement outcomes represents a significant challenge against the backdrop of increasing choice and flexibility.
The Guidance Guarantee is an initiative from the government whereby all retirees will receive the opportunity to discuss their retirement options with someone impartial when they are 6 months from taking pension benefits. This guidance will be delivered by the often maligned Money Advice Service (MAS) and the more experienced Pensions Advisory Service (TPAS). Both these organisations will only deliver ‘guidance’ on the options available and will therefore attempt to refer retirees for ‘formal advice’ where the need is identified. Formal advice will be extremely valuable for many and it is important that the referral concept works efficiently and effectively to ensure ‘best outcome’ and client interests are maximised. Encouragingly, there does appear to be some overall logic and a natural flow and progression from MAS to TPAS and then to formal advice.
While the guidance guarantee is a positive move and hopefully will evolve over time, it is also important to understand its limitations:
- Delivering the guidance guarantee 6 months from retirement is too late for many and some will already be on course for a poor outcome by the time they receive their ‘guidance guarantee’.
- It is vital to align your pension investment strategy to your likely retirement income solution over a number of years before retirement.
- Over 80% of DC pension scheme members use default funds which naturally de-risk investments in the years preceding retirement and are predicated on the retiree taking a ‘cash + annuity’ option at the point of retirement.
- However, for those retirees looking to take advantage of pension drawdown options, it will be necessary for them to keep their pension invested and take on some risk in an attempt to maintain longer-term purchasing power; de-risking investment strategies are therefore the exact opposite strategy to what these retirees should be taking.
- The guidance guarantee is a one off event whereas retirement planning for anyone who defers annuity purchase will be an ongoing process.
- Once you choose to defer buying an annuity, it becomes vital to manage a number of risks including longevity, inflation, investment, withdrawal and sequencing risks.
- Things will change – whether it be at a personal level or in the wider market context - and what might have been appropriate last year or 5 years before that, may not be appropriate now.
- For the majority of people, it is not whether but when to buy an annuity that matters – as we get older, drawdown becomes increasingly unsuitable as the opportunity cost of rising mortality subsidy takes effect. Without more ‘guidance’ or ideally formal advice, how will people know when to come out of drawdown and buy an annuity to secure their income for life?
- Last but not least, drawdown is fundamentally more complicated than an annuity and brings additional risks into play.
- Guidance will be relatively simple to provide for an annuity purchase where there is a range of definitive options but for drawdown it is far more complex and it is likely drawdown will be under-represented at the guidance stage and the mechanism to refer for formal advice will need to be highly effective to mitigate this issue.
So, while I am highly supportive of the new pension reforms and guidance guarantee, it will be important that pension members, trustees and employers are taking steps to ensure effective engagement prior to the guidance guarantee to help members make informed decisions and help them to maximise their opportunity to achieve a quality retirement outcome.
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